Leasing and pay-per-use gain traction as MSMEs rethink machine tool investments

By Staff Report March 3, 2025 1:59 pm IST

MSMEs are rethinking machine tool investments as leasing and pay-per-use models gain traction amid rising borrowing costs. Zubeen Mehrotra, Chief Business Officer, Profectus Capital, shares insights on the financing trends, challenges and solutions that can shape the manufacturing sector.

How have recent interest rate trends impacted machine tool financing for manufacturers?

The RBI is mandated to manage inflationary pressures, and it decides to keep the nation’s overall interests in mind to adjust the repo rate, CRR, etc. This may have a short-term influence on the financing landscape for machine tool manufacturers, and we have seen increased borrowing costs, which have, in turn, presented certain challenges for MSMEs. Consequently, some MSMEs opted to defer capital investments in machinery due to the high cost of financing. While government initiatives have provided some mitigation, elevated borrowing costs and inflationary pressures have been worrisome for MSMEs.

We appreciate the RBI’s proactive approach and welcome the 25bps cut in Repo Rates in Feb 2025, which could be a prelude to the changing tide in the Interest Rate regime. It is an encouraging sign for the coming quarters.   

What financing challenges do MSMEs face when investing in machine tools?

Indian MSMEs face several challenges when seeking finance for investments in machine tools. Some key hurdles are assessed credit vulnerabilities, risk premiums for borrowings, collateral requirements and limited awareness about government and quasi-governmental schemes.

While MSMEs may have established businesses, reliance on only 3-4 large corporate clients for their revenue is considered a credit vulnerability, necessitating a mitigating risk premium on benchmark interest rates. This increases the overall cost of financing, thereby putting pressure on MSME’s margins. Lenders may also require hard collateral in addition to machines being funded to mitigate the riskiness of the overall proposal, thus posing further hurdles in raising debt for expansion purposes. While our central government and apex financing institutions like NABARD, SIDBI and others have deployed financing programs for MSMEs, much remains to be done to introduce these schemes to potential borrowers.

How are leasing and pay-per-use models shaping machine tool acquisitions?

Leasing machine tools and pay-per-use options for certain asset models are having an increasing impact on the way Indian MSMEs acquire machine tools. These alternatives provide practical solutions to the conventional method of outright purchases. BBroadly, leasing significantly lowers the initial financial burden for MSMEs. Instead of a large capital outlay, they can access advanced machinery with manageable monthly payments. This frees up working capital for other critical business needs. Another benefit is that leasing enables MSMEs to acquire the latest (top-of-the-line) machine tools that may be unaffordable. This helps the MSMEs to improve productivity, quality, and competitiveness.

Leasing could also present certain challenges. The total payments over the lease period could exceed the cost of purchasing the machinery outright, and these machines may not be fully customisable.

The pay-per-use model aligns costs with actual machine usage. MSMEs only pay for the time or output they utilise, making it a cost-effective solution, especially for those with fluctuating production volumes. MSMEs in the printing and packaging industries generally operate on this model since the print jobs may not be of predictable volumes every time. By avoiding large upfront investments, pay-per-use helps MSMEs maintain a healthy cash flow, which is crucial for their financial stability and growth. There is flexibility and scalability with pay-per-use as agreements can be tailored to match varying production needs, thus allowing MSMEs to scale their operations easily. This is particularly beneficial in dynamic market conditions.

Although pay-per-use models lower upfront costs, the per-unit cost of production may be higher than owning the machinery.

How does one go about seeking finances for a pre-owned machine? Are these schemes any different from those for new machinery?

Indian Machine / Equipment Leasing market has an addressable fresh-sales Revenue of almost 135k crores as of FY 24. The pre-owned machinery market is a multiple of this volume and accounts for a very high percentage of the business. Profectus Capital, however, operates very selectively in this large market. Assets with documented lifespans beyond 15 years, for example, offset printers and radiology equipment like CT and MRIs, are in-scope.

Pre-owned machinery schemes are unique compared to new machines given the key requirement of determining the balance of useful life, estimated maintenance, replacement cost and the residual value at the end of the machine’s life. Thus, MSMEs looking for finance for pre-owned machines will be well advised to identify, inspect and obtain a basic valuation of the machine under consideration and then approach lenders in this category. Other nuances like confirmation of ‘no loan dues’; ‘lien’ release marked by the previous lender(s), if any, and original bills will have to be available for perusal and review by the lenders. A strong credit score (750+) significantly improves loan approval for purchasing used machines.

How do you evaluate the creditworthiness of manufacturers for machinery loans?

We adopt a comprehensive and industry-focused approach to evaluating the creditworthiness of manufacturers here at Profectus Capital. We recognize that traditional credit scoring provides only a partial view. We believe lending decisions should be based on more than just financial figures. We assess the MSME’s practical expertise with similar machinery, scrutinise their business model with a focus on cash flow and the potential revenue boost from the new equipment, critically analyse their market reputation and customer relationships, and review the repayment histories and their context. We spend considerable time understanding how the machinery will be integrated into the operations, evaluating capacity utilisation and existing work orders. This thorough operational assessment guarantees an informed lending decision that supports business growth.

What innovative financing models are emerging in response to evolving manufacturing needs?

In light of the changing needs of the manufacturing industry, some new-age financing models are evolving. These models address special issues such as heavy capital outlays, variable demand, and continuous technology updates.

The revenue-based financing model primarily consists of two types. The first is revenue-sharing agreements, where financiers provide funding in exchange for a percentage of future revenue, aligning repayments with the business’s performance. The second type is royalty financing, which is similar to revenue-sharing arrangements but specifically focuses on the sales of a particular product or technology.

Equity crowdfunding is where manufacturers raise funds by selling micro-equity stakes to investors. Peer-to-peer lending is where individuals directly lend to borrowers (could even be MSMEs) through organising platforms. The terms are generally more flexible than commercial lenders.

Another model is green financing, where green bonds are issued to finance green projects, energy-efficient equipment or sustainable production processes. There are sustainability-linked loans, where the interest rates are linked to the success of sustainability performance targets, thereby encouraging “green” behaviour.

Government and development bank schemes offer subsidised loans with low interest to finance manufacturing expansion. They also offer credit guarantee schemes to promote specific lending objectives. State or Central Government guarantees are provided to SPV trusts, which in turn provide guarantees to lenders on behalf of the identified manufacturers, thus mitigating risks for lenders and enabling easier borrowings for manufacturers.

Hybrid financing models include combo-financing, where various debt schemes are combined (e.g., machinery financing and working capital financing) for diverse requirements. The blended yield on this is lower than specific-purpose loans.

Mezzanine financing combines debt and equity financing, offering more flexible repayment structures. This type of financing reduces short-term financial pressure, benefiting MSME borrowers during their early years.

Through these models, manufacturers can improve their cash management, invest in new technology, and adjust to evolving customer needs, ultimately stimulating growth and competitiveness in the manufacturing industry.

How should manufacturers balance CAPEX vs. OPEX when considering machine tool investments?

Manufacturers must evaluate their financial health, industry growth prospects, and emerging trends to determine the best allocation of resources between capital expenditures (CAPEX) and operational expenditures (OPEX). By conducting a thorough cost-benefit analysis, assessing return on investment, understanding the total cost of ownership, and identifying potential risks, companies can make strategic decisions that align with their goals and financial objectives. Although investing heavily in the latest technology will increase efficiency and productivity, it may also lock up much-needed capital which could be used elsewhere in business. Conversely, cutting on machine tool investments can result in increased maintenance expenditures and reduced manufacturing capacity down the line. Finding the optimal balance between CAPEX and OPEX, therefore, is the key to optimising profitability and maintaining competitiveness in today’s fast-changing manufacturing environment.